Corporate Taxes, Strategic Default, and the Cost of Debt

44 Pages Posted: 7 Nov 2012 Last revised: 27 May 2013

See all articles by Ali Nejadmalayeri

Ali Nejadmalayeri

University of Wyoming - College of Business

Manohar Singh

Willamette University - Atkinson Graduate School of Management

Date Written: November 7, 2012

Abstract

The current U.S. tax code’s loss carry provisions provide implicit tax subsidies to financially troubled firms. Since shareholders ultimately decide when to announce bankruptcy, such tax subsidies can incentivize them to strategically postpone default. Therefore, corporate taxation can influence corporate cost of debt. Using a large panel of corporate bonds, we find supporting evidence: credit spreads become smaller as tax loss carries grow larger. In contrast, tax shields such as depreciation, which limit loss carry gains, lead to wider spreads. Interestingly, when stockholders hold greater bargaining power ― due to large managerial ownership ― larger corporate tax shields lead to even narrower credit spreads.

Keywords: Corporate tax, Credit spreads, Endogenous bankruptcy, Strategic default

JEL Classification: G11, G12, G13

Suggested Citation

Nejadmalayeri, Ali and Singh, Manohar, Corporate Taxes, Strategic Default, and the Cost of Debt (November 7, 2012). Journal of Banking and Finance, Vol. 36, 2012, Available at SSRN: https://ssrn.com/abstract=2172502

Ali Nejadmalayeri (Contact Author)

University of Wyoming - College of Business ( email )

1000 E. University Avenue
Laramie, WY 82071
United States

Manohar Singh

Willamette University - Atkinson Graduate School of Management ( email )

900 State Street
Salem, OR 97301
United States

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